China's Corporate Social Credit System Dec 11, 2019 22:23:26 GMT 4
Post by Sapphire Capital on Dec 11, 2019 22:23:26 GMT 4
China's social credit system, including for corporate organizations, aims to be fully functional by 2020.
Businesses across China are already being categorized according to their compliance standards and audit and financial records.
Incomplete information from the government and discrepancies across pilot regions implementing the social credit system have produced several myths about how it will impact foreign businesses.
Foreign firms and businesspeople are advised to seek local expertise and ensure full compliance with corporate laws and government policies to avoid being 'blacklisted'.
China's social credit system is an ambitious initiative to build a database that monitors individual, corporate, and government behavior across the country in real time.
According to the Chinese government, the system will use big data to build a high-trust society where individuals and organizations follow the law. It will do so by assigning social credit scores to each entity based on their behavior, which are translated into a variety of rewards and punishments.
Since it was formally announced in 2014, the plan has received considerable attention in international media for its potentially dystopian capability to monitor and control individual behavior.
While these concerns are valid, they do not represent the full scope of the system and its more benign aspects, particularly as it relates to business. Moreover, a number of myths and misconceptions have arisen about what the social credit system is, how it works, and what its implications will be.
With this confusion in mind, we offer an introduction to China's social credit system and how foreign businesses should prepare for its implementation.
What is China's social credit system?
Although most reporting on the social credit system has focused on its relationship with individual citizens, it applies to two other groups as well. There is one social credit system for citizens, one for businesses and other organizations, and one for government officials.
Broadly speaking, the main purpose of the social credit system is to monitor and assess each group's trustworthiness, particularly as it relates to following laws and other rules.
For citizens, this mostly relates to creditworthiness in a similar way to how credit scores work in Western countries. While the system has the potential to be abused, its main purpose is to address the problem of China being a low trust society with limited credit information on each citizen.
For example, because most citizens lack credit history, it is difficult for entities such as banks to assess who can be trusted to repay a loan that they might issue. The system goes beyond financial trustworthiness, though, and keeps track of individuals' legal infringements and, in the future, potentially other types of behavior as well.
For businesses, the system focuses on ensuring that they follow laws and regulations and pay taxes in an appropriate and timely manner, though product and service quality will also be measured. The goal, according to the government, is to create a fair, transparent, and predictable business environment.
The social credit system is slightly different for government officials, who are assessed on criteria such as the extent to which they carry out orders from the central government.
Discrepancies between central instructions and local implementation have long characterized Chinese politics, and in recent years the center has made it a higher priority to restore top-down control. More generally, the government social credit system seeks to ensure that officials are politically loyal, well performing, and corruption-free.
How China's corporate social credit system works
The corporate social credit system collects, aggregates, and analyzes data from businesses to create a score that determines rewards and punishments.
According to a report from the European Chamber of Commerce, businesses and other organizations collect data on their own operations and submit them to relevant local and national authorities, who then consolidate the data in the National Credit Information Sharing Platform, which is a centralized database.
Government authorities also submit data on businesses directly through standard government inspections. This data is then integrated in the National Internet+ Monitoring System, which analyzes the data to calculate ratings.
Businesses are mostly assessed on standard regulatory and compliance criteria that they are already legally required to fulfill. This includes paying taxes on time, holding requisite licenses, meeting product quality standards, and fulfilling environmental protection requirements. Additionally, companies are subject to an array of industry-specific requirements depending on the nature of their business.
The social credit system does, however, put forward some new and stricter requirements. One of the most potentially problematic is the need to take responsibility for business partners. Even if a company meets all of its legal requirements, it can still be penalized if, for example, one of its suppliers is on a blacklist.
Companies with poor scores face a number of penalties. For example, they may be inspected or audited more frequently by regulators, be excluded from public procurement opportunities, unable to benefit from incentives, and be publicly named and shamed.
Further, because businesses are responsible for their partners, it will be harder for companies with low scores to build relationships with other entities.
Businesses can fall on a blacklist either from a poor social credit score or from a particular violation that also negatively impacts a score. China already has numerous national and regional blacklists for various types of violations that will be integrated with the social credit system.
Conversely, high scoring companies will be placed on a "redlist". Besides complying with legal and regulatory requirements, businesses can boost their scores through positive actions like corporate social responsibility activities, which may relate to participating in government initiatives such as poverty alleviation.
The rewards of being on a redlist are somewhat unclear, but appear to involve less frequent inspections and audits, streamlined administrative procedures, and fast-tracked approvals, among other benefits.
Current status and misconceptions
The government plans to launch the social credit system nationwide by the end of 2020, as outlined in the State Council's Guideline of the Construction of Social Credit System, which was released in 2014.
Nevertheless, while the social credit system will not formally be fully in effect until 2020, at least 33 million businesses have already been assigned a score and many have been put on various punitive blacklists. This national-level evaluation is combined with dozens of regional pilot programs, making the system as it currently stands highly fragmented.
The variety of local programs rather than a single unified national system partly explains why so much conflicting information about the social credit system has emerged. Pilot regions differ in what data they collect, how they assess and rate that data, and how they dole out the resulting rewards and punishments.
Some observers mistakenly believe that the ratings assigned to citizens within a pilot region are the same as those assigned to businesses, but this is not usually the case. The city of Suqian, for instance, has eight levels of scores ranging from AAA to D, while the city of Wuhu has a numerical score that ranges between 350 and 1200. These, however, only apply to individuals and not businesses.
That is not to say that the individual and corporate credit systems do not interact at all. For example, if an individual with a poor rating registers a business, the business will automatically have a poor rating, and vice versa.
Differentiating between Alibaba's Sesame Credit and social credit rating
As well, the social credit system is frequently conflated with private credit rating providers, particularly Sesame Credit operated by Ant Financial, an affiliate company of Alibaba.
This program is separate from the national social credit system and is optional to use, though in some ways is conceptually similar in its use of big data to analyze behavior and produce ratings. Notably, Sesame Credit is only used for individuals and not businesses.
Alibaba has, however, participated in building the infrastructure of the government social credit system.
China's unreliable entities list
The social credit system is sometimes conflated with other punitive lists aimed at businesses, namely the unreliable foreign entities list. The unreliable foreign entities list was borne out of US-China trade tensions and targets foreign companies, organizations, and individuals deemed to have "severely damaged the legitimate interests" of Chinese firms.
Because the list emerged from the trade war and has unclear criteria, it is widely considered a retaliatory tool that can be deployed to target entities that fall under the cross-hairs of geopolitical tensions. The list has not yet been formally released, and may only be released if US-China trade tensions continue to degrade. If it is released, it is possible that the list may interact with the social credit system.
For example, a company placed on the unreliable entities list may have their rating suffer as a result, but at the moment it is unclear whether a low rating itself will cause a company to be placed on the list.
Prepare for full implementation
The social credit system is in some ways the consequence of China's efforts to streamline its business environment and cut bureaucratic red tape. Chinese authorities are hoping that streamlining the business environment can boost its economy, but at the same time do not want to lose oversight over businesses and other entities.
In this sense, the corporate social credit system is a mechanism by which authorities can create a self-regulating market with a streamlined administration but also detailed and strict oversight.
The social credit system, while stringent, may benefit foreign companies in some ways.
It could potentially level the playing field with domestic competitors, who are not always regulated as closely as their foreign counterparts. The system will make regulatory enforcement more consistent and standardized across regions.
At the same time, the social credit system puts much more regulatory pressure on domestic and foreign companies alike.
Whereas before infringements could be contained to a particular region or department, now violations will be shared across regions and bureaucracies, and can have a cascading effect. Further, it is possible that the system will be used to punish entities that run afoul of the Chinese government for non-legal reasons, such as in the recent case of the NBA.
To prepare for the full implementation of the social credit system, businesses should first identify what type of information they will need to provide to authorities. They should then undergo an internal audit to ensure they are complying with all relevant regulations.
In addition, businesses are advised to undertake a supply chain audit and conduct due diligence on business partners given the inclusion of partners in social credit assessments. Businesses should also not forget to assess their IT and data security strength since they will need to transmit data to the government more frequently and in greater numbers.
Lastly, businesses may want to explore the extent to which their operations align with the government's priorities. This does not only refer to corporate social responsibility practices that support government initiatives, but also how a business fits into the government's wider policy priorities. For example, a business that supports domestic innovation may have an easier time navigating the social credit system than a heavily polluting manufacturer.
Although the social credit system will soon approach its fully functioning form, its exact nature is still somewhat unclear. This is not just because of the prevalence of myths and inaccurate reporting, but also because of sometimes unclear and incomplete information from the government.
Nevertheless, it is clear that compliance in China will be more important than ever before. Businesses should take immediate steps to avoid inaugurating the social credit system by finding themselves in a deep hole to climb out of.